Market Commentary - Quarter 4 2013 March 2014

Market Commentary - Quarter 4 2013

The macro-economic back-drop generally improved during the fourth quarter of 2013 with the economic recovery continuing to gain momentum, not only in the US, but also more recently the UK and parts of Europe. China also saw a stabilisation in the growth rate together with the announcement of a reform programme, which was received positively by the market.
In the last outlook we identified the three issues that were likely to determine the performance of equity markets during the fourth quarter. The first of these was the dependence of global markets on accommodative Fed monetary policy. In other words, could markets continue to deliver gains if tapering came back onto the agenda? The second issue was Europe and how sentiment would be affected by matters such as the German election. The third issue was China and whether the economy could smoothly adjust to a slower rate of growth.
To some degree all countries and markets are united by a common dependency upon the US Federal
Reserve (Fed). Volatility in markets has generally been caused by speculation over how imminent Fed tapering is likely to be.  At times good news has been bad news, as stronger data increased fears of an imminent reduction of liquidity. December saw the first instalment of this liquidity withdrawal with total monthly purchase of US treasuries and mortgage-backed securities reduced by $10bn down to $75bn. Unlike what happened in May, this reduction in monetary stimulus was generally seen as a positive with equity markets showing small gains. The Fed’s action was translated as policymakers having more conviction in the sustainability of a US economic recovery. The level of tapering will continue in 2014 but growth prospects for the US economy mean this is unlikely to derail recovery.
In the fourth quarter the euro rallied, as expansion of the ECB’s balance sheet has been slower than that of the Federal Reserve. In contrast, both the yen and emerging market currencies have suffered weakness. Whilst Japanese authorities have actively encouraged weakening of their currency this has not been the case for emerging markets, which have suffered from fears of a withdrawal of liquidity. This has resulted in a focus on current account deficits and weaker economies in the region with a need to enact a reform programme to bring currency stability.
In an environment of improved economic growth, but still low interest rates, 2013 was the year for equities, as they comprehensively out-performed bonds and most other asset classes. 2013 saw some rotation from bonds to equities - whilst not the great rotation predicted by some, it is likely to continue gradually for a number of years unless there is a downward lurch to economic growth.
Despite stronger growth many commodities performed poorly, as investors factored in a slower long-term growth rate in China. It was also a year when developed markets out-performed the emerging world, as relative economic change favoured the major stock markets.
In fixed interest the thirst for yield continues to be favoured with higher yielding assets, including corporate loans, performing strongly. With growth rates likely to stay low, even though the recovery has now moved to a sustainable path, interest rates are unlikely to rise significantly over the next few years, as an end to US tapering is only pressing down less hard on the accelerator rather than hitting the brake. While some commentators had expected a pickup in inflation, lots of cheap money doesn’t necessarily provide demand for credit. So far the stimulative effects of QE have been mitigated by the effects of de-leveraging in the financial system. 
The size and growth of government balance sheets suggests some asset prices have been distorted by Central Bank policies. Although there is now a synchronised recovery, it is questionable as to whether governments or individuals could afford rate normalisation after the damage to balance sheets done by the financial crisis. In 2014 there is likely to be a modest draining of global liquidity - the Bank of Japan has been a late arriver to balance sheet expansion and will continue to pump money into the system. There is already evidence that Japanese investment institutions are recycling some of this money abroad.
Overall 2014 has started positively with encouraging economic data but improving global growth across all regions is still someway off and will need to be reflected in company earnings through 2014 for this momentum to continue. 

Market commentary provided by Rayner Spencer Mills – Quarter 4 2013

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